Friday, February 06, 2009

Three Common Errors About Adam Smith

“Adam Smith gave us an excellent metaphor when he compared free market forces to an “invisible hand” that guides each of us — in the pursuit of our own interests — to promote the interests of others.

But Smith, in some ways, set economic thinking back by embracing some mistaken ideas. For example, Smith believed that the value of a thing sprang from the amount of labor that went into its making. Before Smith, several economic thinkers realized that a thing’s value was in the eye of the beholder, but Smith stepped into this mistake nonetheless.

Smith also erred in believing trade springs from an inclination among men to “truck and barter.” In other words, Smith argued that people exchange with each other because of some innate human tendency to swap.”

CommentBut Smith didn’t compare ‘free market forces’ to ‘an invisible hand’. His use of the 18th century metaphor was not about markets; it was about how some merchants, but not all, react to their ‘concern for their security’ by avoiding the real risks of overseas trade by opting to trade locally,. Thus adding to local investment and, thereby, increasing local investment above what it otherwise would be, and increasing local employment and local output.

Having given this as the causes of the actions of some local merchants, in contrast to others who took the risk in pursuit of higher profits, the used the metaphor on ‘an invisible hand’ for those who didn’t follow his reasoning about the causes of their actions. It was the real risks and concerns for the security of their capital that led some merchants to act as they did, and thereby unintentionally benefit local society.

His explanation would survive scrutiny without the later use of the metaphor, but the metaphor would no make much sense without his prior explanation. Therefore, the metaphor is redundant, and didn’t mean anything like what was credited to it in the 1950s by modern economists.

Smith didn't believe that the 'value' of something was determined by the amount of labour undertaken to make it in commercial society; he believed that in a 'savage' hunter society that the exchange value would be determined by the amount of labour the two hunters would take into account (plus 'higgling and bargaining'), because when labour is the sole factor involved that was all there was to consider (the two hunters unambiguously owned the product of their labour).

But the situation changed once other factors came into existence - the land was owned by the landlord who charged a rent; the initial subsistence consumed by the labourer was advanced by the owner of surplus subsistence goods, who loaned it to make a profit from the sale for money.

He made philosophical points about the exchange value of items were accorded their purchase price by the 'toil and trouble' a labourer saved by not having the makle them, a wholly reasonable idea philosophically, of similar standing to the natural inclination of all people to 'seek to better themselves'.

Smith's assessment of the 'propensity to truck, barter, and exchange' was not 'innate'; it arose from the 'faculties of reason and speech', i.e., deep in what we call prehistory.

Readers can download my paper from Lost Legacy Home Page (clikc of the link in red), 'On the Pre-history of Bargaining: a multi-disciplinary treatment, Part I', which I presented last year in Rome at a meeting of the European Association for Evolutionary Political Economy.